Puerto Rico filed for bankruptcy protection last week in a move that will deliver yet another shock to the island’s battered economy and hasten the migration of its population to the US mainland.
It was fanciful to think that Puerto Rico, a US territory in the Caribbean, could engineer a voluntary restructuring of its $70bn public debt. The economy has been in a secular slump for the past 10 years, and more than 10% of its population has left for the mainland. Debt as a share of gross national product stands at over 100%, and its unfunded pension liabilities exceed 50% of the size of its economy. The island has 18 separate bond issues, each of which has different legal protections or claims to different streams of government revenues.
In the light of such highly compromised public finances, it is unsurprising that Governor Ricardo Rosselló requested protection from the island’s creditors under the Puerto Rico Oversight, Management and Economic Stability Act, which the US Congress passed in 2016. That said, it is shocking that he took so long to act in what is by far the largest bankruptcy of a local government in the US. Creditor lawsuits have been flooding in since 1 May, when a Congressional moratorium on such litigation expired.
Bankruptcy protection should provide Puerto Rico with the framework for an orderly and fair restructuring of its debt. However, it is a mistake to think that this alone will solve the island’s economic and social problems.
The island needs to supplement its budget consolidation with serious efforts to reform and modernise the economy. Action is particularly needed in respect of the labour market and to make the economy more hospitable to domestic and foreign investment.
Congress could help with this difficult adjustment process. It should start by repealing the onerous 1920 Jones Act, which greatly increases the island’s maritime transportation costs, and by making social healthcare funds for the island more readily available.
Structural reforms are all the more important because of the prospective tightening in aggregate demand policy that the island faces. Not having its own currency or monetary authority, but sharing those of the US, means Puerto Rico must expect higher interest rates and a stronger dollar in the year ahead.
Puerto Rico’s economic outlook is blighted further by the draconian budget-tightening that Rosselló agreed at the behest of the island’s financial oversight board. The board was imposed on the island by Congress last year. Its programme involves cuts amounting to as much as 6% of the island’s GNP over the next four years. This could mean a further prolonged decline in the island’s economy.
To date the Puerto Rican government and its oversight board have failed to devise a comprehensive and coherent plan to revitalise the island’s economy. Puerto Rico urgently needs an International Monetary Fund-style programme involving debt relief in return for a commitment to far-reaching reforms.
The initiation of bankruptcy proceedings should remind policy-makers in San Juan and Washington of the urgent need to implement substantive reforms that will facilitate growth. Failure to do so risks pushing the island’s economy beyond the point at which a rescue is possible.
Desmond Lachman is a Resident Fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund’s Policy Development and Review Department and the Chief Emerging Market Economic Strategist at Salomon Smith Barney.